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Bank notes - June 2014

Since our last edition there have been lots of events happening both in Australia and overseas, a sample of which is as follows:

Russia invaded Ukraine and has retaken control of the Crimea Peninsula. President Putin justified the show of force by claiming he was protecting the Russian citizens in Ukraine.

Malaysian Flight MH370 disappeared on its way from Kuala Lumpur to Beijing and is thought to have turned around mid-flight and crashed in the Southern Indian Ocean. To date no trace of the plan or its black box has been found despite extensive search efforts being conducted.

Iraq has erupted again in sectarian violence which has made some commentators suggest the Iraq war effort was a waste of time, money and more importantly lives. We wonder whether the same may occur in Afghanistan once all the remaining troops leave at the end of 2014?

Chinese investment in Australian real estate. The substantial increase in Chinese buying activity in Australian real estate, both for agricultural land holdings and in northern Australia and Queensland and more importantly the upper end residential property market. Some commentators say it is just the beginning of a major trend now that Chinese controls in expatriation of funds have been eased.

Economic News

Budgets

Consumer confidence plummeted as a result of the deliberate pre-budget leaks in May. The Federal budget was also very tough. The intention to reduce expenditure has its merits, however the way the Coalition went about implementing and selling the budget was poorly orchestrated.

Question: When is a new tax not a new tax? Answer: when it's a levy, and we have plenty of levies embedded in our tax system including a new proposed deficits tax in the budget.

If the deficit tax is approved, Australia's highest tax rate will be in the top five in the western world.

The key issue is the extent to which the Coalition can get its key budget initiatives passed through Parliament and more importantly through a difficult Senate. Already the Coalition has been working hard to persuade the balance of power Palmer United Party to support key measures. It will be interesting to see what, if any, compromises result from that process.

Stock market

Given all the economic and political uncertainty the stock market appears relatively resilient, as does the Australian dollar which is hovering in the early 90 cents against the US dollar, creating further angst to exporters and manufacturers.

Interest rates

Rates appear to be on hold for most of the remainder of 2014.

Employment

The employment rate is steady at 5.8 percent which is surprising given all the doom and gloom and low consumer confidence although surprisingly, the GDP on recent reports appears to be holding up better than most analysts would have expected which begs the question - exactly how is the Australian economy really faring?

Building the Lucky Country - positioning for prosperity

Deloitte released a paper recently exploring 25 hot spots with the biggest potential to lift Australia's growth over the next 20 years.

Next growth waves – the 'Fantastic Five' sectors of gas, agribusiness, tourism, international education and wealth management. If we address the barriers to their success, Deloitte estimates these could be worth an extra $250 billion to the economy over the next 20 years, have the potential to match mining and keep Australia near the top of the world's prosperity charts.

Future growth waves – 19 growth pockets that, if they have the same relative potential to unlock growth, could contribute at least a further $150 billion to Australia's economy. More importantly, these growth pockets are mainly in high job creating areas of the economy.

The report recommends 20 sites for potential redevelopment of surplus or unproductive land that could raise the Victorian State approximately $4.9 billion in additional revenue which could be used to fund new infrastructure.

At only 34 pages long, it is a succinct and stimulating read and provides interesting food for thought.

National Commission of Audit

As a precursor to the Federal budget, the National Commission of Audit was established to examine the scope and efficiency in the Commonwealth Government, to review the state of its finances and advise on steps to ensure Australia's long term fiscal strategy is responsible and sustainable.

The Commission found that Australia confronts a substantial budgetary challenge. The fiscal situation is far weaker than it should be and the long term outlook is ominous due to an unsustainable increase in expenditure commitments on all fronts.

The Commission has proposed 64 recommendations to place Commonwealth spending on a more sustainable long term footing. The problem is that both political parties in the recent past have offered big promises of increased spending to appease voters based on unsubstantiated revenue inflows.

Given the present political situation with the Government trying to pass its budget, it will be interesting to see the extent that these audit commission recommendations actually come into being.

Recent legal developments

Tacking of advances, the perennial issue

The recent Supreme Court of Victoria decision in Salta Constructions Pty Ltd v St George Bank1highlighted the perennial problems of a senior lender making further advances after it received notice of a subsequent security interest.

The circumstances regarding this case can be briefly summarised as follows.

The borrower was a member of a group of companies which carried on business as property developers. The group was provided with financial accommodation by a number of banks, including St George.

In December 2003, one of the group members granted a first mortgage over a property in West Perth as security for the liabilities of the group members. Under the security, the mortgagor was prohibited from creating or allowing to exist any other security interest over the mortgaged property without the consent of St George.

Subsequently other group members provided guarantees to St George for liabilities incurred by other companies within the group and their guarantees and obligations were secured, amongst other things, by the West Perth mortgage.

In 2007, St George provided the group with a commercial bill facility where the security included the mortgage over the West Perth property. The bill facility was to expire on 1 June 2019.

In September 2008, Salta Constructions entered into a building contract with a group member for the construction of an office building. Under its agreement with Salta the obligations of the principal (the group member) under the contract were secured by mortgages and other securities offered by the group, including a second mortgage over the West Perth property.

Salta gave notice of the security to St George.

In a dispute about priorities between competing creditors, Salta argued that giving notice of its security interest to St George meant the continued rollover of the expired bill facility should be considered 'new advances' and therefore rank after the advances made by Salta. This was on the basis of the rules applied in the case known as Hopkinson v Rolt2 which prevented a first mortgagee having received notice of a subsequent mortgage from gaining priority for further advances secured by the subsequent mortgage. Salta alleged that once notice was given to St George of the security to Salta, the new advances were not covered by St George's first mortgage and ranked behind Salta's security.

Conclusion

Despite lengthy arguments, the Court determined the operation of the rule of tacking of further advances does not apply to the rollover of commercial bills, because it relates to an existing, rather than a new liability. Accordingly Salta's argument failed and its security ranked behind St George for further advances.

It has been suggested that this is a surprising result in light of prevailing case law.3

To protect against this result, the practice of bankers when put on notice for second mortgages is to stop drawings from the overdraft account so no further fresh debt is created after receipt of the notice. The problem is overcome, and the overdraft can be reactivated, once a priority agreement between the mortgagees is put in place.

Although the case was decided on a different basis, it is worth noting that to a certain extent the rule in Hopkinson v Rolt has largely been superseded by section 58 of the PPSA which now recognises that future advances by a secured creditor will be given the same priority as original advances so long as the terms of the arrangement giving rise to the security contemplates future advances to be covered by the security interest.

Law of penalties

Readers may recall that there has been a recent run of class actions against several major Australian banks in relation to the allegation that the charging by banks of fees for late payments overdrawings and the like constituted a penalty and was therefore unenforceable.

There has been a further recent case in this series of Paciocco v ANZ Banking Group Limited.4 It was handed down in the Federal Court of Australia.

Facts

Mr Paciocco and one of his companies, Speedy Development Group Pty Ltd (SDG), held an account with two consumer credit cards.

ANZ imposed a variety of fees on its customers including a late payment fee of $35 and other fees consisting of honour fees, over limit fees, dishonour fees, outward dishonour fees and overdraft fees of between $20 and $37.50.

Mr Paciocco and SDG alleged the contractual terms entitling ANZ to charge these fees constitute penalties of common law and in equity. Alternatively, if the fees did not constitute penalties then it was contended as follows:

ANZ was engaged in unconscionable conduct

the consumer credit cards account fees were unjust

the exception fee provisions were unfair contractual terms.

The decision

Late payment fees: because the fee applied whether the payment was one day or one week late or the default was $1.00 or $1000, constituted a penalty.

Other fees: these were held not to be penalties because they were proposed as consideration for the provision of further services.

Unconscionable conduct: the Court held the Bank's conduct was not unconscionable, unjust or unfair.

Consequence for Banks

The decision means finance companies and banks who impose the fees will need to be able to demonstrate that the fees they charge are justified on the basis that the fee is consideration for providing an additional service, or a genuine pre-estimate of the cost to the business. The decision also means finance companies and banks are recommended to review their fees, especially if they apply without any grace period, in particular regarding late payment fees.

Bank debit fees only after default

It is recommended that financiers should debit default fees after default has incurred and the actual cost (after the payment default has remained unremedied for a certain period) can be determined.

As a consequence, extreme care needs to be taken when drafting loan agreements particularly regarding the circumstances where transaction fees are entitled to be charged.

Final comment

Both parties have indicated an intention to appeal the decision as it has substantial ramifications to the banking indusry particularly all of the various class actions which are either on-foot or are threatened in similar circumstances.

Market observations

Since our March Bank Notes, the banking and finance team at Maddocks has noticed a generally higher level of transactional activity than at this time 12 months ago, with the lead up to the end of financial year being busier than usual.

Property finance, some M&A related activity and corporate refinancings have kept us busy but the ongoing level of caution in proceeding with transactions has continued among a number of our clients, reflecting the trends and impacts mentioned above.

A genuine substantial increase in transaction volumes resulting from large scale infrastructure developments coming on stream or from an increased level of mid-market M&A activity still appears a way off.

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